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The Winning Move for E*TRADE?

The discount broker finally joins its peers in offering ETFs.

E*TRADE Financial(Nasdaq: ETFC) has gone through a lot this year. Under pressure from major investors, the discount brokerage company announced it would put itself up for sale in the hopes of putting a stop to its steadily eroding stock price.

Yet when E*TRADE said last month that it had chosen to stay independent, I said there was one thing it needed to do to stay competitive in the industry: make a partnership with an exchange-traded fund provider to offer commission-free ETFs to its customers. And now, E*TRADE has announced plans to do just that -- and it has put together an impressive lineup of ETFs in its new commission-free program.

Below, I'll reveal why E*TRADE's new ETF offerings vault it back into contention among the industry's top brokers. But first, let's review how E*TRADE got so far behind -- and what its competitors have already done.

Two years late?The whole idea of commission-free ETF trading started two years ago, when Schwab(NYSE: SCHW)created its own line of ETFs in-house for customers to use. Next up was Fidelity , which used a slightly different strategy: Rather than focusing on its own ETFs, it went to outside provider BlackRock to offer a menu of 25 popular iShares ETFs to its customers. It later expanded the list to 30.

Next, other brokers got on board. Vanguard already had an extensive lineup of ETFs, so it was simple to open them up to brokerage customers at no charge. Scottrade chose to offer Morningstar-based index ETFs from its FocusShares affiliate, while Interactive Brokers(Nasdaq: IBKR) offered outside ETFs with a unique leveraged spread strategy. And TD AMERITRADE and Firstrade chose to go across ETF-brand lines to pick the cream of the crop of funds, with TD choosing an extensive list of more than 100 ETFs while Firstrade stuck with a simple set of 10.

So what was left for E*TRADE? That's where I got it wrong: State Street(NYSE: STT) and its SPDR line of ETFs are still without a dedicated brokerage partner.

Finding wisdomInstead, E*TRADE went with three separate providers to put together a menu of more than 90 ETFs. WisdomTree has built a strong reputation in the industry for certain innovations, including its fundamental-weighted index ETFs that track metrics such as earnings and dividends rather than market cap. It also has started focusing on international investments, offering foreign-aimed ETFs like WisdomTree Emerging Markets Equity(NYSE: DEM) and WisdomTree Emerging Markets Local Debt(NYSE: ELD).

In addition, E*TRADE has added funds from Global X, which had also made a deal with Interactive Brokers. Global X's funds let investors drill down on individual sectors, countries, and investing strategies. For instance, its Global X Lithium ETF(NYSE: LIT) has become a popular way to play the increasing demand for lithium-ion battery technology and alternative energy.

Finally, the broker is also using 10 ETFs from Deutsche Bank's db-X. They include five target-date funds and five international equity ETFs.

Will it help?Clearly, despite offering a wide array of ETFs, E*TRADE chose not to tap into the raw asset play that State Street would have brought. To me, that suggests that State Street simply isn't interested in partnering with a discount broker -- raising the possibility that it may try to offer its ETFs directly at some later point, although it may merely be trying not to alienate any of its institutional clients who might chafe at State Street singling out any one institution over another.

E*TRADE clearly had to make a move to be competitive in the ETF world, and this represents a strong step. While lacking the sheer diversity of TD AMERITRADE's ETF smorgasbord, E*TRADE did a good job of bringing together ETFs that will help its customers build diverse and eclectic portfolios. Given how late the company was to the party, E*TRADE did pretty well.

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Fool contributor Dan Caplinger applauds E*TRADE for making the right move. You can follow him on Twitter here. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Interactive Brokers. Motley Fool newsletter services have recommended buying shares of BlackRock, Morningstar, Interactive Brokers, and Charles Schwab. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy is always a winning move.

Author

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.
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